How to tell if your market is in a bubble or not

from Burnaby, B.C.

posted over 4 years ago

Something I heard a while ago is that if renting a home is cheaper than buying it in an area, then most likely that area is in a bubble. For example in my area a single family detached home (4 bedroom, 2-3 bathroom) starts at around $750,000. The same home rents for approx. $2500/month. Buying the home with a 10% down payment and at an interest rate of about 2.5-3%, monthly payments are approx. $3,000 over 35 years. If mortgage alone would cost more than renting a home, isnt that a sign that the market is in a bubble? What do you guys think?

I live in Vancouver, BC and it is very hard to find a single detached home in the area for less than $700,000. Although I know the area is nice, I still can't see the value in the home or the land. I'm looking to start renovating homes in the area. Would you guys recommend for a beginner to start further out where homes start around $350,000-500,000? Or try to find a private lender and start in a high priced area like Vancouver?

Real Estate Investor from Seattle, Washington

replied over 4 years ago

I would not use that bubble logic, rent vs buy as a rule of thumb. Although BC sounds like Seattle and I have watched Seattle prices jump significantly each week lately and pending offers within two days on the MLS on these props. Most of these offers are bidding the price up on the already inflated price.

If you are new I would not take that much risk for a first time project. Move where houses are cheaper for your learning curve and less net capital risk.

No one knows if the market is in a bubble or not. In 2007 most everyone was thinking the market would keep going and going up. You will not know if it is a bubble until after the fact.

In Seattle I look at how fast the prices are going up and the average household income (it has been going down the last few years). I have no idea how these avg people are affording to buy. Developers have also started buying at peak prices speculating on more appreciation.

I have seen a handful of properties on the MLS change their price +$40K at once then they go pending a few days later.

Also look at the area job market.

Buy low and sell high it is that easy but many think they are missing out so they buy (into the bubble).

In my market and most of the South East you can build a nice 2,500 sq/ft home for approximately $100 per sq/ft.

Adjusting for higher wages and slightly higher material cost let's assume it cost $150 to reconstruct a home a home in your area.

2,500 sq/ft x $150 per sq/ft = $375,000.

Now you can deduct the new home value from the average price of a home in your market. $750,000- $375,000= $375,000 in just the tiny postage sized plot of dirt the home sits upon. That's where the inflation is, and yes it's absolutely ridiculous...

Investor from Snohomish, Washington

replied over 4 years ago

If you compare rent vs buy on graphs over a period of time there is usually a point when the buy supersedes the rent, but it's usually a timeline of 3-5+ years or something. I haven't done it in a while. When I did it I was taking into account inflation, value increase, rent bumps on a 20 year historical average. Who knows what the future has in store. You could argue there is a mini bubble with everyone rushing to lock in lower rates as they are on the rise.

from Burnaby, B.C.

replied over 4 years ago

@Zach Schwarzmiller When you say "timeline of 3-5+ years" do you mean that is how long the "buy" supersede's the "rent"? Or simply the length of time you are focusing the study on in that given market? Sorry, didn't catch what you meant by that.

As far as interest rates go, from what I understand, they are decreasing here in Canada.

I didn't mention this, and I should have, the rents in this area have also been increasing. But, it seems as though the buying/affordability of owning is outpacing renting. I also think that a number of people who are buying homes are doing so with equity that they already had in their previous home.

@Ed L. That is a good way of assessing the value/price of a home. I didn't think of it that way. From what I understand the average price around this area for building a new home is about $200/sqft in Canadian currency (which is roughly $180/sqft American). So at $200/sqft x 2,500 sqft = $500,000 for the home. $750,000 was the price I gave for the lower end homes. In regards to new construction, in Vancouver you are looking at anywhere from $1.5M and up, depending on the specific area. That would mean that for that new home the purchaser is paying about $1M just for the land. In your opinion, what is a reasonable price to pay for land, relative to the value of the home? Should it be less than the actual value of the home?

I have another question; since I'm looking to flip homes, and hopefully I can turn the home over in 2-3 months, should I really even worry about whether the market is in a bubble or not? If I found a home that wasn't on the market, and I found a private lender, and was hypothetically able to purchase that home for cash, for less than the average price for a similar one, then I'd be getting a good deal whether the market is in a bubble or not, right? I guess my question would be, how big of a risk is it if I'm really only looking to turn the property over in a very short period of time. Can a bubble burst within 2-3 months?

Investor from Snohomish, Washington

replied over 4 years ago

I don't have it anymore but I had a really interesting graph a local economist I met with made showing SFR demand vs Renter Demand going back to the 60's and in history they were making waves and for the first time since back then they were going up together. The study went way back, the years were how long they reside in one property. I didn't do the study so I forget some of it now.

Residential Real Estate Agent from Hattiesburg, Mississippi

Many times coastal cities have high land values because they are landlocked from expanding by the bordering ocean or river. Same can happen if a city is surrounded by government owned/controlled land such as a national forrest. They simply run out of land to build on that is within a reasonable commuting distance from the city center/job center.

Lack of supply can drive up demand and what people are willing to buy....

This isn't a major problem as long as wages are correspondingly high and average people can afford to keep buying average properties..

You have to look at the average wage and what it takes to qualify for a average property..

For example,

Assuming a average home in Vancouver is going for $750,000. Using a 30yr mortgage, 20% down payment, 4% interest, 1% annual property taxes, and 1% annual insurance premium.

That means the average person in Vancouver is going to need a $150,000 down payment, and a income to support a $4,200 mortgage for 30 YEARS...

That means that the average person is going to be spending $50,400 a year on their mortgage payments.

Not sure about Canada, but in the US banks will not loan if your annual mortgage payments is greater than 28% of your gross income.

That means a person buying a $750,000 home in Vancouver will need to be making at least $180,000 per year on top of the $150,000 down payment...

Here's the twist- If the median income in Vancouver is $200,000 then there wouldn't necessairly be a bubble.. Just a comparatively pricey real estate market brought on by unusually high incomes...

The problem is "The average income in Metro Vancouver in 2009, was only $41,176"

"Only 0.56 per cent of British Columbians declared incomes higher than $250,000, says Andrew Romlo, executive director of Urban Futures, which studies demographics. That’s less than the proverbial 1 per cent that owns everything."

from Fredericton, New Brunswick

replied over 4 years ago

Originally posted by @Gary McGowan :
Yes, Vancouver is overpriced at the moment. However according to Stats Canada for 2013 the average income in Vancouver was $82,899. Times two incomes per household.

Gary,

Is that statistic average income amongst homeowners? The figures given for housing prices - coming from StatsCan and the Realtors Association(s) / MLS - indicate housing prices in Vancouver range from just over 7.5 to as much as 11 times household income. The national average is 5.7.

from Burnaby, B.C.

Gary, I'm curious where you found that number $82,899 as an average income in Vancouver? Are you sure that isn't a combined household income? So far all I have found is $68,970 for a household income in Vancouver back in 2011. It would make sense if it rose up to $82,899 by 2013 as a household income, but not as a single person's income which you could times by two per household.

Ed, thank you for your reply. That is an interesting article. It is sort of widely known in this area that the market is heavily influenced by foreign, mainly Chinese, investors. My girlfriend works at a showroom for an upcoming building development which includes three-30+ storey buildings, 2 low-rise buildings and some townhouses. She tells me that 90% of the buyers are Chinese investors. It makes sense, as the article was pointing out, that foreign investors are "parking" their money here in Vancouver, since it is relatively "cheap" for them to do so and it is a safe haven from their perspective. When you compare real estate prices between Vancouver and China, they are actually getting a bargain. In my personal opinion the bubble won't burst until it is no longer in the foreign investors' best interest to invest here. That would mean that the prices in Vancouver would have to be higher or near China's prices. Of course that may happen if the Canadian government decides to make it more expensive for the foreigner's to invest by taxing them. Again, no body can really predict the future...

from Colorado Springs, Colorado

Developer from Vancouver, British Columbia

replied over 3 years ago

Hi all, what a great discussion.

@Bojan Kovacevic Hope you got into the market a year ago as vancouver is hot and has risen once again.

We also get in and out of property investments in short timeframes 5-7mnth for a complete Reno and 8-12 for a new build which is less risky than long term but coming form Sydney Australia I have seen what is happening in Vancouver all before and I can tell you that my soeculation is this is no bubble but in fact a city adjusting to the rest of the top cities and their house prices around the world. It will continue to go up and then flatten, who knows maybe a 5% correction if a change for foreign investors or global economic markets occur but then it will go up again and again. Over the next twenty years it will never go below today's price just like twenty years ago.

In my market and most of the South East you can build a nice 2,500 sq/ft home for approximately $100 per sq/ft.

Adjusting for higher wages and slightly higher material cost let's assume it cost $150 to reconstruct a home a home in your area.

2,500 sq/ft x $150 per sq/ft = $375,000.

Now you can deduct the new home value from the average price of a home in your market. $750,000- $375,000= $375,000 in just the tiny postage sized plot of dirt the home sits upon. That's where the inflation is, and yes it's absolutely ridiculous...

In Sonoma County California, ocean-front properties are asking form $500+ per square-foot. Is that too much? It is indeed a very beautiful stretch of ocean. I don't mind buying expensive goods if the value is there; like gold reasonably (or unreasonably) costs more than copper. How do I gauge what Sonoma ocean-front properties are worth?

from Los Angeles, California

replied over 3 years ago

How many times have you heard somebody say some version of this statement: “We made 100,000 on the sale of our house and we only lived there for five years. Can you imagine if we continued to rent the apartment we used to live in all that time? We would have lost all that money…

What they really mean is that they sold the house for $100k more than they paid for it.

Most of us here on BiggerPockets chime in to help new investors, so I put this post together hoping to help them on this topic.

I have long been an advocate of renting your primary residence vs. owning it. A lot of years ago, I wrote a technical paper on this topic (long before there were blogs or MicroSoft Word). It turns out I was right. Well in most circumstances, anyway.

For the record, I own two homes (I paid cash for the both).

Of course there are several financial factors that are involved when making a decision like this.

Home price

How long will we live there?

Down payment amount

Future economic factors

Maintenance costs

And that concept call Opportunity Cost

I ran across this Post in the New York Times today and I’ve spent two hours analyzing it.

Here’s my synopsis: We are all involved in real estate because we know how to, or we are trying to learn how to, generate a secure and attractive rate of return on our money.

I regularly double or triple my money or more buying and selling vacant land. Usually in less than 30 days (or I don’t do buy in the first place).

The input in the post only allows for a 20% annual return. If it went any higher the argument for renting would become even stronger.

The opportunity cost of tying up all that cash, time & energy is almost never worth it.

One of the only times it makes since to finance your primary residence is when you know you are buying a property substantially under market, and reselling it. Some folks call that flipping. Or if you buy a duplex, live in one side, and work the deal so the tenant is paying all or most of the mortgage (some circumstance like that).

Buying a rental house (or 20) the right way, and renting them out forever is one of the best passive business models I’ve ever experienced. This discussion is only about your primary residence.

And that’s just half of the decision. The other half is location. Every apartment or townhouse I’ve ever lived in centered around a ton of fun. Every house I’ve lived in was in the quiet suburbs where we did chores on Sunday.

A few years ago, I sold my primary residence and paid cash for a townhouse in Old Town Scottsdale, Arizona smack in the middle of all the fun. We completely renovated it and I can’t imagine living anywhere else.

It was one of the best financial and lifestyle decisions I’ve ever made.

Specialist from Toledo, OH

How many times have you heard somebody say some version of this statement: “We made 100,000 on the sale of our house and we only lived there for five years. Can you imagine if we continued to rent the apartment we used to live in all that time? We would have lost all that money…

What they really mean is that they sold the house for $100k more than they paid for it.

Most of us here on BiggerPockets chime in to help new investors, so I put this post together hoping to help them on this topic.

I have long been an advocate of renting your primary residence vs. owning it. A lot of years ago, I wrote a technical paper on this topic (long before there were blogs or MicroSoft Word). It turns out I was right. Well in most circumstances, anyway.

For the record, I own two homes (I paid cash for the both).

Of course there are several financial factors that are involved when making a decision like this.

Home price

How long will we live there?

Down payment amount

Future economic factors

Maintenance costs

And that concept call Opportunity Cost

I ran across this Post in the New York Times today and I’ve spent two hours analyzing it.

Here’s my synopsis: We are all involved in real estate because we know how to, or we are trying to learn how to, generate a secure and attractive rate of return on our money.

I regularly double or triple my money or more buying and selling vacant land. Usually in less than 30 days (or I don’t do buy in the first place).

The input in the post only allows for a 20% annual return. If it went any higher the argument for renting would become even stronger.

The opportunity cost of tying up all that cash, time & energy is almost never worth it.

One of the only times it makes since to finance your primary residence is when you know you are buying a property substantially under market, and reselling it. Some folks call that flipping. Or if you buy a duplex, live in one side, and work the deal so the tenant is paying all or most of the mortgage (some circumstance like that).

Buying a rental house (or 20) the right way, and renting them out forever is one of the best passive business models I’ve ever experienced. This discussion is only about your primary residence.

And that’s just half of the decision. The other half is location. Every apartment or townhouse I’ve ever lived in centered around a ton of fun. Every house I’ve lived in was in the quiet suburbs where we did chores on Sunday.

A few years ago, I sold my primary residence and paid cash for a townhouse in Old Town Scottsdale, Arizona smack in the middle of all the fun. We completely renovated it and I can’t imagine living anywhere else.

It was one of the best financial and lifestyle decisions I’ve ever made.

Investor from East Wenatchee, Washington

In super high-priced markets, or when dealing with luxury homes, I agree it makes sense to rent. Where else can you occupy a $2MM mansion with 18ft ceilings for only $5k/mo, right?

For the rest of us mortals, there are tons and tons of intangibles I have experienced that advocate buying. We have 2 dogs we didn't need permission to get, we just renovated my sons bedroom, we landscaped our yard, we had an overnight BD party and didn't have noise complaints, etc. Plus there's the 121 tax on gains exclusion here in the states.

For the record, my home also has a mother-in-law apt that brings in rental income. I agree a normal home is not an 'asset' that puts $ in your pocket, but something has to be said for owning your own home and not needing permission from your LL to modify your home or have a pet! Cheers!

from Fredericton, New Brunswick

replied over 3 years ago

Adding to @Steve Vaughan 's list. In Canada one does not pay capital gains tax on the disposition of your primary residence.

So, for those who are brave enough, and whose pockets are sufficiently deep, to have been riding the real estate speculator rocket in Vancouver or Toronto this past decade you would be smiling. It would be a toss-up whether you were investing or merely participating in an alternate form of craps, but there would be smiles nonetheless.

Account Closed

.. if renting a home is cheaper than buying it in an area, then most likely that area is in a bubble. ..

This is a definition / discussion about 'housing bubbles' by Karl E Case & Robert J Schiller. This might help better understand if you are in fact experiencing a housing bubble in your local market:

"...the term refers to a situation in which excessive public expectations of future price increases cause prices to be temporarily elevated. During a housing price bubble, homebuyers think that a home that they would normally consider too expensive for them is now an acceptable purchase because they will be compensated by significant further price increases. They will not need to save as they might, because they expect the increased value of their home to do the saving for them. First time homebuyers may also worry during a housing bubble that if they do not buy now, they will not be able to afford a home later. Furthermore, the expectation of large price increases may have a strong impact on demand if people think that home prices are very unlikely to fall, and certainly not likely to fall for long, so that there is little perceived risk associated with an investment in a home..."

Does this describe the current environment in your local market? What you did describe is evidence of there being a housing affordability issue but just price escalation does not by itself imply that there is a bubble.

This being said, the monetary policy in Canada may either trigger or defuse a bubble.

Investor from Williamsville, New York

@Bojan Kovacevic Hope you got into the market a year ago as vancouver is hot and has risen once again.

We also get in and out of property investments in short timeframes 5-7mnth for a complete Reno and 8-12 for a new build which is less risky than long term but coming form Sydney Australia I have seen what is happening in Vancouver all before and I can tell you that my soeculation is this is no bubble but in fact a city adjusting to the rest of the top cities and their house prices around the world. It will continue to go up and then flatten, who knows maybe a 5% correction if a change for foreign investors or global economic markets occur but then it will go up again and again. Over the next twenty years it will never go below today's price just like twenty years ago.

That statement right there sounds like a bubble. When you have a majority of people that speculate and invest with the same idea that prices will never go down and at worse case scenario be flat for a short period of time. It's a recipe for a huge correction/crash. Just pull any 100 year term chart on housing, oil, gold, and stock prices and you will see a series of extreme ups and downs. For a market to be flat or steadily go up then flatten would mean a serious balance of people buying and selling on an almost perfect equilibrium. People are not rational, markets are not rational.

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